Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Diamond Offshore Drilling, Inc. (NYSE:DO) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Diamond Offshore Drilling
What Is Diamond Offshore Drilling's Debt?
As you can see below, at the end of September 2023, Diamond Offshore Drilling had US$535.2m of debt, up from US$335.5m a year ago. Click the image for more detail. However, because it has a cash reserve of US$146.8m, its net debt is less, at about US$388.4m.
How Healthy Is Diamond Offshore Drilling's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Diamond Offshore Drilling had liabilities of US$261.5m due within 12 months and liabilities of US$757.2m due beyond that. Offsetting this, it had US$146.8m in cash and US$225.4m in receivables that were due within 12 months. So it has liabilities totalling US$646.4m more than its cash and near-term receivables, combined.
Diamond Offshore Drilling has a market capitalization of US$1.29b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Diamond Offshore Drilling can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year Diamond Offshore Drilling wasn't profitable at an EBIT level, but managed to grow its revenue by 30%, to US$912m. With any luck the company will be able to grow its way to profitability.
Caveat Emptor
While we can certainly appreciate Diamond Offshore Drilling's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at US$10m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled US$66m in negative free cash flow over the last twelve months. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Diamond Offshore Drilling is showing 1 warning sign in our investment analysis , you should know about...
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.